Archive for July, 2010
Market Breakout Or Breakdown?
Whereas traders and the media tend to get hung up on short term charts, if we take a look at a 5 year chart of the SPY we can get a better idea of what is going on in the U.S. stock market. The S&P is getting squeezed in a massive equilateral triangle. This chart formation has an equal chance of breaking out to the upside or downside.
Right now the S&P is bumping its head against the 21 day moving average (the light grey line) and appears to be hitting stiff resistance here. The MACD is below 0 but may be turning up and the stochastic is heading higher. Volume has been steadily decreasing since the April top. If the market does rally it will probably be capped at the upper downtrend line that is about 1200 on the S&P. A decline would bring us to at least the lower uptrend line that is around the 1020 area.
A break of either trend line in the current time frame would indicate approximately a 200 point move on the S&P in the breakout direction. If the break is to the downside, the move could be doubled. If that were to happen things could get really ugly as we could be testing the bear market lows of 2008.
It should also be noted that the longer the index stays in this pattern the smaller the breakout move will be. In any event the S&P is going to be forced to breakout in either direction within the next few months. If it breaks out right at the apex there may not be any significant move in the market in either direction and we could wind up with a range bound market.
Since we are very near the treacherous September-October time frame, the leading U.S. economic indicators are weakening, and there are numerous other bearish patterns and indicators on the major charts, I suspect the ultimate resolution will be to the downside although that is in no way a definite outcome.
The market has been reacting to dollar weakness and Euro strength, but the Euro at 130 is hitting resistance from a long term downtrend line and this situation could reverse on a dime. Interestingly enough, the pundits have been wrong about bonds. All we have been hearing for the past year is that yelds have to go up due to the massive debt that is being accrued by world governments but so far the exact opposite has happened. Any one who has attempted to short bonds during this time period has gotten crushed.
Will bond yields eventually go up? At some point in time I would imagine they have to, but that time doesn’t appear to be now. In any event the strength of bonds without corresponding strength in the dollar could also be another indicator of both economic and stock market weakness.
Beware Of This Stock Market Rally
I have 2 charts today: that of the SPY and the VIX. You can see that the SPY has rallied right up to the downtrend line formed from the April top. The Dow has also rallied to its downtrend line but the QQQQ hasn’t quite made it.
Volume has been steadily declining since the April top, the MACD is under 0 and has stayed there since May even though there have been counter trend rallies, and the stochastic is in overbought territory. If you compare the stochastic movements to the SPY price movements, the stochastic has been a reliable timing indicator for market turning points.
The VIX has dropped to the uptrend line formed from the April low and it has also formed an equilateral triangle. According to the stochastics the VIX is in oversold territory. While it is not shown in the chart, the VIX has pulled back right to it’s 200 day moving average.
The problem here is that the VIX has never really dropped to more normal levels during any of these rallies. This indicates that the professional traders are not buying into the rosey scenario currently being announced by the talking heads at CNBC.
While the market did reverse to the upside from below the neckline of the head and shoulders pattern, I suspect that this rally is just about done and another right shoulder will be formed before the market plunges.
Due to good earnings being announced by Intel and other companies, I would not be surprised to see an initial move up tomorrow followed by a larger move down. The problem with earnings is that it is past history that is already priced in. While intel did give good future guidance on chip sales, that guidance has not been affirmed by the computer manufacturers.
Tomorrow looks like an excellent day to put in some short positions on any of the major indices. A tight stop should be used just above the downtrend line to minimize any losses in case the market breaks through to the upside but based upon the current technical conditions of the market that seems unlikely to happen.